Question

ESPN Case Study Setting: October 2017. Executive Officers meeting to discuss the most recent financials (Year Ended October 1, 2017) for The Walt Disney Company. The officers have just completed their discussion of Disney Media revenues and the positive financial impact the Star Wars franchise is having on the company. Background: ESPN has been a cash cow for the Disney Corporation, essentially a license to print money. In the past Disney/ESPN has been able to increase ESPN rates, the cable providers protest, but in the end pass on and/or absorb the rate increase because of the popularity of the network. However recent events are impacting ESPNs ability to profit and questions about its future profitability. First, viewership is down. Second, cable subscription rates are down. Third, it is harder for ESPN to push rate increases down the line to the cable providers. Finally, ESPN has signed numerous contracts with various sports (NBA, NCAA, NFL, etc.) to carry games, high profile matchups, and playoff and championship games on their network. To outbid other networks (CBS, FOX, NBC, etc.), they have had to (not without financial analysis) bid high amounts, increasing their costs. Due to lower subscriber levels, ESPN has laid off several hundred employees. Officers Present: Name, Age, Title Officer Since Robert A. Iger, 65 Chairman and Chief Executive Officer 2000 Alan N. Braverman, 68 Senior Executive Vice President, General Counsel and Secretary 2003 Kevin A. Mayer, 54 Senior Executive Vice President and Chief Strategy Officer(2) 2005 Christine M. McCarthy, 61 Senior Executive Vice President and Chief Financial Officer(3) 2005 M. Jayne Parker, 55 Executive Vice President and Chief Human Resources Officer 2009 John Skipper, President of ESPN Inc. Stephanie Druley, Senior Vice President, Event and Studio Production; Rob King, Senior Vice President, “SportsCenter” and News; Burke Magnus, Executive Vice President, Programming and Scheduling; Connor Schell, Senior Vice President Robert: Turning our attention to ESPN. John can you give us an update on the financials of ESPN and where they network is headed and what suggestions you, and for that matter anyone else in the room have for rectifying the situation. John: Thanks Robert. As you all know cable subscribership is down over the last several years. In fact, the declinein cable subscriber since 2011 is 16%. This decline however has not been fully passed on to ESPN since the number of households still subscribing to ESPN is only down12% over the same time period. This indicates that our brand is still strong. Now the reason for the disconnects or cord cutting is still muddy. We know the vast majority of cord cutters are millennials, but cable subscribers are seeing it across the age spectrum as cable costs rise, which arguably we share the blame for with our rate increases to cover the cost of expanded content. We know household spending on entertainment is still increasing, but not as much as in the past, growing only 2-4% in recent years. So the good news here is that we are outperforming subscribership and that household spending on entertainment is still increasing, slower than in the past, but we have an opportunity to try and grab some of that spending. Christine: John, Can we really say that we are outperforming “subscribership”. I hear that other “Sports” Networks such as Fox Sports, NBC Sports are up 8% over the same time frame. Further, I know that for Major League sports branded networks, such as the NFL Network and the MLB Network that viewership is up 25% and 14% respectively over the same time period you cite. John: That’s true Christine, but they have a smaller base, so smaller increases in subscribership can lead to large percentage increases. Christine: Agreed, but they are still growing, what’s the reason they are growing and we are declining. Is it better content? Better coverage? What? John: Well truthfully Christine, we have treated ESPN like a cash cow for Disney. If we were going to miss analyst expectations or if we won a bid to cover a playoff or championship game and to cover the costs of the latter, we would just raise rates. We took the mentality of “build it and they will come” and that business model worked for a number of years, but we have created our own problem. Even the most expensive sports network only charges $3.86 per month, but Fox Sports costs $1.30, NBC and CBS Sports cost $0.32 and $0.26 respectively. The NFL Network is $1.40, MLB Network is $0.26 and NBA TV is $0.23. The Big Ten, Pac-12 and SEC Networks range from $0.39 to $0.74. We charge $7.21 per subscriber for ESPN. Most of us feel at ESPN that we have contributed to the cord cutting problem. Cable is bundled of course, and as cost for cable programming rises it gets passed on to the subscriber. Research shows that the cost increase is driving the cord cutting problem. For example, Millennials are much more likely to go watch a game at a restaurant or bar or just check their smartphone for updates, rather than get ESPN. Compound this with a-la-carte TV and another demographic, older Americans on a budget will argue why they should pay $7.21, plus markups, for ESPN when they don’t even watch ESPN. Frankly as concerned as I am about cord-cutting, they move to a-la-carte could hurt ESPN even more since millions of American pay for cable and might not ever watch ESPN. Kevin: Robert how much are we paying for contracts to cover sports? John: Our yearly payment to the NFL is $1.9 billion, the NBA $1.5 billion, MLB is $700 million, to the NCAA, the NCAA Championship Football and the various NCAA Conferences is about $1.5 billion. All total about $5.6 billion. We have other contracts which brings the total to roughly $6.5 billion. In some cases these contracts increased by as much as 245%. Kevin: 245%? Can we renegotiate these contracts? John: No, in fact many of these contracts have yearly increases and any to attempt to negotiate them would result in losing the contract. Christine: John if you recall back in 2014 when we were negotiating the NBA contract for three times what we were paying, I noted the weakness in subscribership and advocated waiting until the contract expired in two years to get additional information on the market, but you disagreed arguing that other networks were waiting to steal the contract from us. In light of the information we have 3 years later do you still agree with your decision? John: I still believe losing content could only exacerbate the decline in viewership. Christine: Arguably, yes, but do you still support the price we paid for the contract? John: Well circumstances have changed… Christine: And we would have had better data in 2016 to support a threefold increase in the NBA contract. Isn’t the contract worth essentially what the buyer is willing to pay for the right to carry the games? John: Yes, but if we didn’t, my team and I truly felt based on information we had that NBC and Fox both wanted the NBA deal. Strategically and financially we might be worse off if we started losing contracts. Robert: I agree with you John on that issue, but when do these contracts expire? John: Unfortunately, most do not expire until 2023, 2024, 2025 and even 2027. When we signed many of these contracts, cord-cutting wasn’t even in the vocabulary. Honestly we missed the repercussions of cable networks telling unhappy subscribers that we, ESPN, was to blame for cable rate increases. We felt then that subscribers would see the cost increase as minimal and that subscribers would see the value in watching the games and sports they loved. Often times the increase was in the range of 30 cents to $1.00. Robert: Ok, now that everyone is up to speed, what can we do to improve a situation that is likely to only get worse. Between cord cutting and a-la-carte TV industry forecasts are that by 2021 the number of cord cutters will equal the number of people that never had pay tv…81 million. I want to let that sink in with the leadership team. That’s about an additional 10% decline from 2016 levels. That’s a decline of about $779 million dollars in revenues from 2016. What options do we have? Alan: Well this is a little out of my expertise, but couldn’t we just create a stand-alone app to allow subscribers to buy and watch ESPN on their TVs, mobile and smart devices? Right now if I want to watch a game on the ESPN app, I need to input my cable subscriber data. Rob: I think that’s a good idea. Stephanie: As good as it may sound, there are I problems with that idea. Cable subscribers would view that as an attempt to by-pass them and go direct to their customers. The people that watch ESPN would go for the app, no doubt, but the problem is the people that do not watch ESPN, under the current structure they pay the cable provider and us regardless of whether they watch ESPN or not. If we entertain the idea of an app, then cable providers might cut ESPN from their lineup. We would still get the people who watch ESPN…they’d get the app and we know those subscribers amount to approximately 62 million, but the people who don’t watch would be fine with a potential reduction in their cable bill, we know those numbers amount to around 29 million. Do the math and that’s $2.5 billion. Do we really want to lose that much in revenues overnight? The stock would plummet! Cable providers have animosity towards us after years of price increases, I’d be willing to bet they would love to stick it to us. And those numbers might be the good news. There’s information to suggest 50% of cable subscribers would cut ESPN to save only $8 per month. Christine: My numbers align with Stephanie’s statement, but to further demonstrate why an ESPN app might work, to make the app revenue equivalent, we’d have to charge $30 PER MONTH. Bruke: People might pay that, we have an excellent lineup of sports we cover, plus the delivery of our content is second to none! Christine: I agree our content is great, but we did a market analysis and only 20% of our customers would pay $20 per month, none would be willing to pay $30 per month. Most see the value of ESPN as $1.45 per month. Right now I just don’t see how we can get there. Conner: Why $30 per month Christine, subscribers only pay $7 today, plus the mark-up. Christine: Conner, it’s because if we move to that model, we lose subscribers. I won’t get into the detail of what those estimates are, but let’s say we end up with 50 million, because we lose about 40 million in potential viewers, advertisers would pay less, if they even keep us at all. Conner: Can’t we advertise on the app? Christine: We would, but some of advertising is locally oriented and we’d lose the ability to get those customers. If you watch the app, you see and ESPN message “We’ll be right back” Basically we couldn’t fill the slot. Required: Analyze the information provided, and any additional information you can gather on The Walt Disney Company. Develop a plan to increase revenues, lower expenses and increase profitability SUBSTANTIALLY. Make sure that if you argue for example to reduce costs by renegotiating sports contracts that you just don’t say you will do it, but provide reasons for WHY you think you can do it. Show financial numbers based on sound evidence. Don’t just say for example I think actually 50% of people will pay $30 per month.

Answer 1

If ESPN decides to build an app then it would lose 50% of its cable subscriber base which would lead to a loss of $ 2.5 billion but the rest of the subscriber base of 62 billion would be willing to pay for the app out of which only 20% i.e. 12.4 million subscribers would be ready to pay for $20 per month which would work out to be $2.5 billion and that would be sufficient to cover up the loss from cable subscribers to whom we can provide ad free content and thus they would be ready to pay $20 per month.

The remaining 80% subscribers i.e. 49.6 million suscribers would pay at the present rate of $8 per month and thus they would be indifferent between cable subscription and ESPN app which would lead to increase in revenues. For these subscribers we would not be providing ad free content. We would earn from ads as well here and the subscription charges.

Also we do not need to cut any amount on the current sports contract charges as they would be similar to the charges we used to pay them in case of cable subscribership as we would be covering the same content in the app as that in case of cable connection. Thus we would end up earning 49.6*8 which is equivalent to $4 billion plus extra revenue from displaying ads as well without the fear of cable providers cutting ESPN from their lineup.